Highlighting the urgent need to address key blockages in Europe’s capital markets, Christine Lagarde, president of the European Central Bank, called for more decisive action to drive growth, innovation and investment across the union. Speaking at the 34th European Banking Congress in Frankfurt on 22 November 2024, Lagarde that, while over 55 regulatory proposals and 50 non-legislative initiatives have been made since 2015 to advance the European capital markets union (CMU), these efforts have often lacked the depth needed for real progress. She pointed out that the broad, fragmented approach has allowed national interests to impede much-needed reforms, resulting in the continued fragmentation of Europe’s financial markets.

Lagarde identified three central issues that block the efficient flow of capital across Europe: the entry, expansion and exit stages of the capital markets “pipeline.” These inefficiencies, she argued, are self-reinforcing and contribute to a stagnation in Europe’s economic potential.

Entering capital markets

Europeans save a high share of their income--around 13% in 2023--compared to just 8% in the United States. However, a significant portion of these savings, approximately €11.5trn, is held in “low-risk, liquid savings products,” making up about one-third of household financial assets. In contrast, US households hold only about one-tenth of their assets in cash and deposits.

Lagarde pointed out that this misallocation of savings in Europe has two major consequences. First, it has resulted in lower household wealth. Since 2009, the wealth of US households has grown by approximately three times more than that of EU households. Second, it has limited the flow of savings into capital markets, thereby restricting long-term investments.

According to ECB analysis, if European households were to match the US deposit-to-financial assets ratio, up to €8trn could be redirected into long-term market-based investments, representing an annual flow of approximately €350bn. One of the key reasons for this low investment in Europe is the fragmented, opaque and expensive retail investment environment. Financial products are often complex, and 45% of consumers report a lack of confidence in the financial advice they receive.

To address these challenges, Lagarde called for the introduction of a “European savings standard,” a set of simple, transparent and affordable financial products that could be offered across the EU. Such products, she argued, would increase competition, reduce fees and encourage savings to flow into more productive, long-term investments.

Expanding capital flows

The second blockage Lagarde addressed was the difficulty in expanding capital flows throughout Europe. She noted that more than 60% of household investments in Europe are kept within national borders, and institutional investors tend to favour US markets over EU markets. This fragmentation of capital flows is largely due to Europe’s highly fragmented financial infrastructure. In 2023, the EU had 295 trading venues, 14 central counterparties (CCPs) and 32 central securities depositories (CSDs), compared to the United States, which has only two CCPs and one CSD.

This fragmentation leads to higher transaction costs for cross-border trading and increases “home bias,” where investors prefer domestic assets over those in other EU countries. According to ECB analysis, this inefficiency results in lower liquidity in European markets, with US companies seeing significantly higher daily trading volumes than their European counterparts.

Lagarde identified a divergence in legal frameworks as a core driver of this fragmentation, which has prevented the creation of a truly integrated financial market. She proposed a two-tier approach to harmonise European financial markets, similar to the approach used for competition enforcement and banking supervision. In such a system, entities meeting certain criteria could fall under EU jurisdiction while still respecting national legal frameworks.

She also reiterated her call for a “European SEC” (equivalent to United States’ Securities and Exchange Commission), an entity that could streamline regulatory processes and help break down national barriers that stifle the growth of cross-border financial markets.

Exiting to innovative sectors

The third obstacle Lagarde discussed was the difficulty of channelling capital from financial markets into innovative sectors and high-growth companies. Venture capital investment in Europe is currently just one-third of US levels, and European VC-backed companies receive, on average, only half the funding of their US counterparts. Furthermore, more than 50% of late-stage investment in European tech companies comes from outside the EU, primarily from the US.

Lagarde warned that European tech entrepreneurs may ultimately choose to list and grow their businesses in the US, a phenomenon she described as an “unintended exit.” To address this, she emphasised the need to fix the demand side of the equation by reducing the bureaucratic barriers that stifle high-growth companies in Europe. She pointed to the reports by and on completing the single market as critical to facilitating greater VC investment in Europe.

To strengthen the supply side of funding, Lagarde recommended three key measures: first, EU pension funds, which currently allocate just 0.02% of their assets to VC (compared with 2% for US pension funds), should be encouraged to allocate more capital to innovation. Second, public development banks, such as the European Investment Bank, should be empowered to pool risks and attract private capital. Lagarde highlighted the success of the European Tech Champions Initiative, which has mobilised €10bn in resources to support 16 tech scale-ups, as an example of what could be achieved with greater funding.

Finally, Lagarde proposed that Europe explore new methods of supporting innovation through debt financing. While venture capital remains the ideal solution, Europe’s bank-based system should be leveraged to provide venture debt--a growing source of funding for start-ups. In 2022, around €24bn was allocated in venture debt, up from just €1bn in 2014. Lagarde pointed out that EU banks lend over €600bn to real estate companies but less than €100bn to technology companies, despite both sectors contributing similarly to economic value.

Call for action

Lagarde concluded by quoting Leonardo da Vinci: “Knowing is not enough; we must apply. Being willing is not enough; we must do.” She emphasised that, while European leaders recognise the problems caused by capital market fragmentation, they have yet to take decisive action to resolve them. The incremental, fragmented approach to regulatory reform, she argued, has allowed vested interests to dilute progress, resulting in the “death by a thousand cuts” of the CMU project.

Lagarde ended her speech with a call for a shift in approach, “A change of perspective from taking a large number of small steps to a small number of large steps--and choosing those that we can actually take and that will make the biggest difference.”